Where You Live Affects What You Earn

The part of town where you live—and especially where you grew up—can profoundly affect lifetime earnings.

“[A] as I check off my list of privileges, I won’t forget the biggest of them all: my passport,” economist Tim Harford wrote in the Financial Times. He’s not wrong: In today’s increasingly spiky world, where financial and social advantage is clustered and concentrated in specific places, the country in which you’re born obviously affects the opportunities you will be presented with later in life. But it’s not just the country—or even the city—in which you’re born that matters, according to a growing body of research. Neighborhood matters just as much, if not more.

A city is not a single, unitary thing, but a collection of neighborhoods. And we know that the outcomes among children who grow up in poor neighborhoods, those with under-performing schools, under-prepared peers and less access to high-quality libraries or museums, are often very different than those who grow up in wealthier areas. These early differences can not only contribute to inequality in terms of wages and income, but also what Stanford University economist Rebecca Diamond calls “inequality of well-being,” where neighborhoods that house high shares of high-skilled workers not only have more money, but also better amenities, like grocery stores and schools. Diamond’s well-being inequality gap, she finds, is 20 percent higher than what can be explained by the wage gap between college and high school grads.

This is what social scientists have dubbed the “neighborhood effect,” and two recent studies give us a better understanding of exactly how it works.

The first [PDF], by Princeton University sociologist Douglas Massey and Jonathan Rothwell, an economist with the Brookings Institution’s Metropolitan Policy Program, examines how the neighborhood in which one lives for the first 16 years of life affects future income between the ages of 30 and 44. The study, which was published recently in the journal Economic Geography*, used data from the Panel Study of Income Dynamics collected by the University of Michigan’s Institute for Social Research, which has tracked a nationally representative sample of individuals and families since 1968.

Numerous studies have already accounted for the ways in which parents have a profound effect on the economic futures of their children. But Massey and Rothwell hypothesize that the characteristics of neighborhoods have an effect on future earnings independent of the well-established roles of factors like parents’ income or education.

The neighborhood effect creates a lifetime earnings gap nearly as large as that between a college and high school graduate.

Their results are striking. Rothwell and Massey find the neighborhood effect to be 50 to 66 percent of the effect of parental income. This means, as they write, “growing up in a poor neighborhood would wipe out much of the advantage of growing up in a wealthy household.” They dub this the “million dollar neighborhood effect,” finding that lifetime earnings are roughly $900,000 higher (or $730,000 in net present value terms) for those who grow up in the richest 20 percent of neighborhoods than for those who grow up in the bottom 20 percent, even after corrected for parental income. As they note, this effect creates a difference nearly as large as that between a college and high school graduate, which the Census Bureau estimates to be roughly $1 million dollars in lifetime earnings.

This neighborhood effect becomes even starker when Rothwell and Massey take cost of living into account. Money goes much further in, say, Des Moines than it does in New York, as they point out. So the researchers built a local price index using housing rental prices and ran their numbers back through their intergenerational mobility models. Their results are depicted in the chart below, from the Brookings Institution:

Of course, the neighborhood effect is also associated with a host of other variables, race chief among them. Massey and Rothwell use two Census tract-based data points to determine the neighborhood effect of racial composition. They find that both variables and the neighborhood effect by themselves are significant in predicting future earnings. But they also find that the neighborhood effect is the most explanatory of the three. As they note, “It thus appears that the lower intergenerational income mobility of African Americans can be explained by their disproportionate segregation in poor, disadvantaged areas.”

A second study [PDF] by my Martin Prosperity Institute colleagues Charlotta Mellander, Kevin Stolarick and José Lobo examines how neighborhood location affects the money people make. The study looks at the effects of residential neighborhoods and workplace neighborhoods on individuals’ incomes in Sweden between 2002 and 2011. Sweden has unusually detailed micro-data that enable the researchers to study the connections between firms, neighborhoods and individual earnings over time in a systematic way. The data include roughly 22 million observations over this 10-year period.

This study employs the concept of “neighborhood effects” in a somewhat different way: Where sociologists focus on the ways one’s early neighborhood conditions affect life outcomes, Mellander and company examine the way that the locations where one works and resides affects current income.

Neighborhoods have a very different effect on the incomes of blue collar and service workers as compared to knowledge and creative workers.

The researchers set out to, in their words, “examine which social community most affects an individual’s productivity.” Their models probe the effect of neighborhood location and workplace on the wages of higher skill knowledge and creative workers versus less-skilled blue collar and service workers, while controlling for education, gender, marital status and other factors.

The big takeaway: Neighborhoods have a very different effect on the incomes of blue-collar and service workers as compared to knowledge and creative workers. First, residential neighborhoods have a relatively bigger effect on the incomes of blue-collar and service workers. This, the researchers suggest, may be because these workers are more likely to “network” with friends and neighbors to find good jobs.

But residential neighborhood location matters less to knowledge and creative workers, whose incomes are affected more by their workplaces. Additionally, creative and knowledge workers receive a clearer income boost from being employed in a workplace within a creative cluster, perhaps because these clusters are also where “they can change jobs frequently, and where firms compete for some talent.”

For decades, urban economists have compared the relative economic performances of cities and metro regions. But this type of research seeks to get inside those cities and metro areas and examine the powerful roles played by neighborhoods. This work is essential to understanding why certain places grow while others do not, and how the powerful divides and segregations within our cities can and will echo into the future.